Although not as prevalent as they once were, defined benefit plans can still be a significant source of retirement income for some individuals. As such, they should be examined closely in the context of a divorce settlement. This is particularly true if the spouse is still working and accumulating a benefit, payable at a future date.

What is a Defined Benefit Plan?

To clarify, a defined benefit plan, also known as a traditional pension plan, provides a defined monthly salary-like payment to an employee at retirement. These types of benefits were historically offered in order to entice workers to stay with one company for years (or even decades). Unlike other retirement plans, defined benefit plans are usually funded entirely by employer contributions, although in rare cases, employees may be required to make some contributions.

There is no single method to calculate the payout of a defined benefit plan. A formula might be based on an employee's average salary for their last three to five years with a company or on the employee's average salary for their whole career with a company. Or there might be a flat dollar benefit, such as $800 for each year an employee has been with the firm. If you are eligible for a pension plan, be sure to check how your benefits will be calculated.

Note: A defined benefit plan should not be confused with a defined contribution plan, which is a tax-deferred account like a 401(k) in which the employee makes regular contributions and is responsible for investing the funds for use during retirement. It has a current value, and the employee receives monthly or quarterly statements; the contribution amount is defined, not the future stream of income.

How Are Defined Benefit Plans Divided in a Divorce?

Ultimately, how assets are divided will depend on the conditions set in your divorce. Generally, there are three methods used to divide a defined benefit plan:

• Present value or cash out—the non-employee spouse is paid a lump sum settlement upon divorce from the pension or a marital asset of equal value.
• Deferred division or future share—the parties do not calculate a current value but instead agree to a future split of the benefit when payable at retirement.
• Reserved jurisdiction—the court reserves jurisdiction to determine the payout at some future point. This is the least attractive, as the parties cannot properly plan for an unknown income stream in the future.

Of course, your unique circumstances will have to be taken into account when deciding which of these methods to utilize in your divorce. For example:

• Will the employee-spouse still be working and the benefit growing after the divorce?
• Was the employee-spouse working before the marriage?
• Is there a cost-of-living increase calculated into the pension amount?
• What does the pension allow—can the non-employee spouse take benefits before the employee spouse retires?
• What if the employee-spouse gets remarried?
• Is there a risk that the employee-spouse could refuse to retire and delay payment to the ex-spouse?

All of these considerations must be addressed with the pension plan administrator and clearly laid out in the divorce settlement and a Qualified Domestic Relations Order ("QDRO"). A QDRO lays out the agreement between the parties and instructs the plan administrator on how to divide the benefit. A person specializing in QDROs should draft the order, as there are many potential mistakes, and it must be approved by the plan administrator to take effect. The approval process can take weeks or even months, but it should be done before the divorce is final to avoid any surprises. You don't want to come to an agreement only to find out later that the plan doesn't allow for what you have agreed to.

Dividing up assets during divorce is complicated, and if your divorce is partially caused by financial disagreements, then the help of a divorce-focused financial planner, officially known as a Certified Divorce Financial Analyst® (CDFA®), may be merited.

Why Hire a CDFA?

Despite the additional up-front cost, the long-term financial benefits of working with a CDFA can be substantial. A CDFA can work with one or both spouses with the goal of a fair and equitable division of assets. An amicable divorce can make the transition easier on both of your bank accounts. If you can come to a mutually agreed-upon settlement, you could save money on lawyer fees and avoid long settlement hearings.

Life After Divorce: Empower Your Financial Future

According to the Pew Research Center, divorce after age 50 is rising. For those involved, this can mean less financial security, which, in turn, can affect your overall life satisfaction. Working with a specialized financial planner that focuses on divorce can not only help you divide your assets but can also help you create a new financial plan considering your goals as you near retirement.

Working with an advisor, like the CFDAs at Wealth Enhancement Group, who specializes in navigating comprehensive financial matters during a divorce can make a difference in your financial future post-divorce.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.